Welcome to No More Risk Better, a Credit Sites Podcast. Across the global strategy team, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets. As the macro makes headlines, we leverage our network of experts across fidget solutions to better understand economic trends, rates, gyrations, geopolitical events, and how these factors impact corporates. At Credit Sites, we understand that credit investing comes down to picking winners to generate alpha and avoiding losers.
Our team over 100 analysts across the US, Europe, and Asia provide unmatched sector expertise and fundamental knowledge. In our weekly podcast, the strategy team offers a look at the conversations we have with our colleagues, including analysts, analysts, strategists, economists, and leveraged finance and market experts. If you want to know more so that you can risk better, you'll want to give this podcast a listen. Hello, everyone, and welcome back to the Credit Sites Podcast.
This is Winnie Caesar, global head of strategy, joining you from the West Coast, where the Sun is shining despite markets not being all that happy. Today, I have Zach Griffith, my right-hand man at my head of US investment-created macro strategy on the credit sites team, and a special guest, Cedric J. Hab, our chief economist at BMI. He also just mentioned that he is the chief of confusion at BMI, so I guess that's something that we will get into, because we are going to talk about all three things, macro, markets, tariffs, liberation, obliteration, pontification, all of these things.
Thank you so much for joining me today, Zach and Cedric. Looking forward to covering all of those very interesting and topical items. Thanks for having me back. There's a lot of questions, and I'm not sure we have that many answers, maybe we'll see.
I mean, I have a lot of answers. Most of them are probably incorrect. So let's start with perhaps some of the most incorrect areas, because Cedric, on the macro side of things, we've seen a massive response from economists, from strategists, from the cell side, from the bi side, from the upside, from the downside, downgrading the economic outlook for the US, and really kind of the rest of the world. That includes Zach and I.
We upped our probability of a bear case or recession in US to 35% with our two Q outlook last week. What is your updated take on the outlook for US economic fundamentals? Are we in a recession? Are we in stagflation?
Stagnation? Obliteration? How are you feeling about things right now? Well, I'm certainly not feeling great because there's so much uncertainty and there's lots of moving parts.
So at this juncture, what we're doing is we're looking at our forecast and trying to assess where the US and global economy is going to land. But of course, we're having to do this in a very short term period and a very tight period, which is difficult. And there's a lot of moving parts. So it's actually really difficult for any economists trying to make a sensible forecast.
If you break it down, though, if you think there's going to be 23% effective tariff rate, that's kind of $700 billion in cost. Now, it doesn't mean that the US bears that alone, but that's about 2.5% of GDP. And so that's kind of where you start working from. Now, the big question is, is there an escalation or is it de-escalation?
If there's an escalation, then I think it's inevitable that we get into a pretty nasty recession. But we think that there is a path for de-escalation. The question is, what is that path? Is it quick and less painful?
So for example, lots of trade deals get signed very, very quickly. We know that South Korea, Japan, they're moving forward quickly with that. And Scott Bessin said that they're over 70 countries that reached out to the administration. So if you have a very rapid de-escalation, I think that mitigates a lot of the risks and mitigates the risk of recession.
But the other alternative is a slow de-escalation, which is then more painful. And that's just because that de-escalation takes several months or quarters. And during those several months or quarters, you have basically negative impacts on the economy through three channels. The first one is the kind of supply and demand shock.
So higher prices as a supply shock and weaker demand from consumers as a demand shock. You also have a wealth shock from markets. So we know S&P is down. If you look at the MSCI World Index down by 17%, that's about $13 trillion in losses.
That's quite substantial. And then of course, you have the tightening financial conditions for US corporate American global corporates and global sovereigns. If you look at high yield spread in the US is what? 4.5% now and all in yields are somewhere closer to nine.
And that's up from seven. So these different channels, until there's more certain people continue to weigh on the outlook for the economy. Yeah, absolutely. And I'm glad that you mentioned high yield.
I want to highlight that we are recording this podcast episode, The Evening of Tuesday, April 8th. So by the time the episode comes out on the 10th, who knows what environment we are actually going to be in. But I think it's definitely worthwhile to be having these conversations. And today we actually put out a note, tactically upgrading high yield to overweight.
We've been underweight credit risk for quite some time. But high yield historically north of 8.5% is a very good buying opportunity, especially if you feel like you can weather a little bit of volatility. But I would say that this is a short-term tactical trade. So focus on more liquid parts of the market or perhaps putting it on through index trades or ETFs as well makes a lot of sense.
But Sutter, back to you. I think that one of the things that comes up quite frequently in my conversations and definitely the broader market conversations is, wow, this was a very aggressive liberation day announcement. It has surprised a lot of people caught them off guard, thus the massive revisions to economic growth expectations and increasing probabilities weighted to recession. How surprised were you by how aggressive Trump has been in his tariff announcements?
I was quite surprised. And I was already on the camp that we were going to see a structural shift in global trade dynamics. So Trump's been very clear that they're structural drivers of these policies. So that includes raising revenue for the US government as a means to share the burden because the US dollar system and the ample liquidity that the treasury market provides for the global economy is a positive externality for the global economy.
And also, of course, the US, the Fenson umbrella, which provides that peace dividend. This is costly for the US government. And so Trump has said he wants burden sharing there. He also had the domestic priorities in terms of immigration, drug flows, crime, et cetera.
He's been talking a lot about supply chain resilience and national security. So for example, the steel industry is not a particularly high-tech industry, but it's fundamentally important for your ability to defend yourself and provide ammunition and kind of scale militarily if you need to. And so that's very important from a defense perspective. He also probably wants to punish some bad actors who've been taking advantage of the global system.
And last but not least, he wants to rebalance, trade, and get investment in the US. He wants to basically drill as much oil as they can and export as much energy. And he also wants other countries to invest their high-tech knowledge into the US. Let me kind of this, for example.
Now I think where we underestimated was how quick and how aggressive he wants to be basically hitting everybody on the head with a 2x4 and, you know, insulting everybody. That was particularly surprising. Because it seems a little bit, well, it seems very unreasonable to the degree of the tariffs and the negotiating style. But then, you know, maybe that's just Trump.
I think an important thing to remember is that Trump knows he has leverage and he has basically, he knows which buttons to push. So for example, the US consumer is, well, the US economy is about 26% of the global economy. The US consumer is 70% of the US economy. So that means that US consumption is 18% of global GDP.
They're above. So he knows that without the US consumer everybody else is in trouble and he's really leveraging that. So that's why I think he's gone so far. I think they're huge risks with that approach.
Yeah, absolutely. I mean, there are so many things in Trump 2.0 that feel just like a amped up version of Trump 1.0 and then there were some big head scratchers. And I think that the sequencing of things with tariffs first and presumably the tax bill second, whereas it was flip flops in the first administration is really interesting and I think has led to a lot of speculation about what is to come next. And Zach, I want to bring you into the conversation a bit because rates markets seem pretty confused about the outlook.
Is it a recession? Is it not a recession? We had US Treasury yields initially dropping pretty significantly in the long end, which has been the focus of Scott Bessent. But now they've retraced higher and with some pretty astonishing vigor.
I think that the move higher in rates was definitely part of our core call for our 2Q 2025 outlook. But it happened quickly and it's happened in tandem with a lot of equity market volatility still. How are you thinking about the drivers of the move in rates and what does this really mean? Yeah, it's been interesting to say the least, Wendy.
And I think in terms of the most recent move back to I think around 4.35 on the tenure, it seems like there are some potentially technical factors at play that are sort of outside the thinking about growth expectations, inflation, and the path for monetary policy. And I guess you could throw on top of that a measure of term premium, which we could debate about that for the rest of the podcast. And I think what you're seeing now is sort of a resetting of expectations in terms of what this trade policy might mean in terms of how other countries respond and maybe what is in their toolbox to respond with. And I think one of the things that's sort of out there in the narrative is there's been some foreign official selling of longer duration treasuries.
Now, maybe that's part of regular portfolio rebalancing or maybe it's a more structural shift away from the US seeing the US as maybe less investable viewing the US dollar and US treasuries at the margin, less of the reserve currency or the reserve safe haven. And so I think that's going to be very difficult to measure in terms of what it could mean for the path of yields, except to say that it could be huge. When we think about your point on the policy sequencing and sort of what we're seeing from the Fed and their reaction function, I think the March FOMC meeting was clearly hawkish to us in terms of taking down inflation or excuse me, taking down growth expectations, taking up inflation. And then if you look at policy makers expectation for the path of policy, it's actually higher if you look at the average dot the median dot didn't really move.
But I think that reaction function might also be getting reassessed. And while I think almost more important for economic growth is the amount of uncertainty that trade policy has brought to the forefront almost as a first-order impact outside of higher prices and then eventually demand destruction from those higher prices, I think that's getting repriced a little bit in terms of how it'll affect rates and the path of monetary policy, at least in the US here. Yeah, I mean, I think the path of monetary policy is such a tricky question. The way that I've been thinking about it is the Fed is either on hold to biased to hike this year or they're cutting a lot.
It's not going to be 100 basis points. Cedric, I'd be curious to hear your thoughts. How are you thinking about what the Fed is going to make over the recent market moves, the potential impact for tariffs? I would note that today, despite continuing market volatility, we had one US investment grade issuer tap the primary market.
So there's still some liquidity out there, at least for the higher quality parts of the market, how you'll definitely shut down, although some loan deals have been done over the past week or so. What is the Fed looking at? Are they super focused on the inflation and labor prints, or are they actually starting to monitor some of these financial market conditions and maybe thinking about easing into it? Yeah, that's a good question.
I think the big difference this time is that a usual recession sees a decline in output, a rise in unemployment and falling prices or disinflation, at least. This is not going to be your normal type of recession because we're going to, if we get into a recession, because we're going to have inflation. And so on average, inflation typically falls by three to four percentage points or so. This time round is probably going to shoot up by one percent point, maybe a bit more.
And that's going to pose a dilemma for the Fed. That's the inflation, right, Cedric? I mean, that's pretty much it, right? Yeah, it's a fact.
So we wouldn't expect that inflation would be very persistent like we saw in the 70s. So that's why it'd be more like a fact. My interpretation of Powell's comments in recent weeks following his presser and also was it last Friday, I believe. So he basically said a few things or this is how I interpret it is we don't know what's going to happen.
So we're going to wait and see. We might deem tariff related inflationary as transitory. And then the third thing he said was, well, we're going to keep an eye on both sides of the medics and whichever one kind of deviates more, we're going to address that. And so I think that's going to be a very important thing to me.
Overall, if you assume that the unemployment rate is going to start rising, private consumption falling and let the businesses not hiring, then I think that skews you a little bit to support growth over your inflation mandates. That's my kind of direction of travel because during COVID, we had both a positive, well, we had a negative supply shock and a positive demand shock with all the stimulus. I don't see where that stimulus is coming from this time. So we're going to have a negative demand shock.
And so combined with lower inflation, essentially that gives maybe a lower commodity prices. That potentially puts disinflationary pressures over the coming months. And so it helps inflation expectations to remain relatively anchored. Will they cut?
I guess I think they will. The question is how fast they would cut? Are they slow to start? Do they provide other types of measures in the interim providing liquidity, for example?
But ultimately, I think they will cut because you will have lower commodity prices, you're going to have weak demand and rising unemployment. And if you look at what Powell said, he keeps on saying he's focused on the long-term inflation expectations and the tenure break evens have fallen quite dramatically. Of course, that's mostly to do with oil and as they track oil prices, but they certainly show that inflation's not becoming ingrained in terms of expectations. That's interesting, Cedric.
Oil prices have been very interesting over the past week with OPEC Plus's surprise announcement about increasing production, which feels suspiciously timed in a number of ways. Zach, on the Fed, the official credit sites call us at the Fed is on hold for the foreseeable future through 2025. How are you feeling about that call? Are there things that maybe Cedric didn't articulate or highlight that you have had top of your mind?
Or where does the Fed go from your view? Yeah. Well, I think your point, Winnie, that we're either on hold for this year. We're cutting maybe 200 basis points.
That's our view. We're going to be making a market being consistently priced for call it three cots, give or take. Feels like a fairly unlikely outcome, but maybe the average of the two outcomes that we see as most likely. I think Cedric's point about focusing on growth and really what I'm thinking about in terms of a slowing global economy, asset prices coming down, a US economy that has seemingly been incredibly reliant on wealthier households.
If you get this reverse wealth effect, how intense will it be? I'd say the move has been fast and furious and probably is having an outsized psychological impact because of how unexpected, at least in magnitude, the trade policy announcements have been, but ultimately does it flow through to the real economy through higher unemployment? Do businesses start to lay off workforce to deal with potentially margin pressure from higher input costs from tariffs? I think that's the key crux of what the Fed is going to do and whether or not we actually see a recession here in the US.
It seems like the strong growth that we've had for the past couple of years, perhaps it's still a long tail of all the fiscal and monetary stimulus in response to COVID. That's probably more or less run out. I feel like we've been saying that for a while now. I would think it's got to have mostly worked its way through the system.
That's how I'm thinking about all of the pressures at play here, absent making a big call on how much of these tariffs remain in place and how much are negotiated away. I think it's really that big shift in unemployment in the labor market that will be the big driver of if we have this recession that people are much more fearful of now and whether or not the Fed is cutting 200 basis points or if they're able to keep things on hold as they remain focused on inflation pressures that we expect to be more persistent and not this one-time adjustment in the price level that others have described tariffs to ultimately do to the economy. The inflationary nature of tariffs, I think it really goes hand in hand with monetary policy, because if monetary policy is still somehow accommodative or loose, even if the Fed is on hold but we still have this growing money supply out there, people are not going to have to be making the decisions about I can't buy as much of this and I have to trade down. And tariffs will be inflationary if we still have the positive money supply angle but things can get pretty disinflationary to deflationary very, very quickly.
So the Fed is in a very tricky spot overall. And you know what else is in a tricky spot is markets and people who have to be in the markets right now, there are a lot of moving pieces. We have rates, we have equities, we have equities, we have FX, we have crypto, all of these different things. A lot of moves, some of them seem kind of overdone, some of them seem head scratching, some of them seem like why didn't this happen three months ago.
So I want to first talk about the dollar. What is going on with the dollar lately? It's been pretty stable, it seems like, which isn't that weird given everything that's going on. Can you just give us a high level overview of the current and future path of the dollar?
Sure, I'll do my best. So basically late last year when they were talks about tariffs, they were inflationary concerns at a time when growth was very strong. And so the path of least resistance there was a reprising of basically Fed and higher rates. And so that was pushing up the US dollar up until very early in the year.
But I think what's emerged ever since then is Trump's policies are so aggressive that even though there is potential for inflation, the growth side of the equation is looking much weaker. And so the path for interest rates might not be higher or might not be as hawkish or it's essentially become much more dovish. And you can see this in interest rates being futures being reprised for three, four, five cuts. So I think there's been a shift in terms of the balance of risks from inflation to growth.
And that's helped the dollar move from around $110, well the dollar index from $110 to about $102. So that's a pretty aggressive move, a pretty quick one. Now over the short term, I think there's reasons why the dollar weakens or stays kind of trade sideways to slightly weaker. And as I mentioned, the growth expectations, I don't know if it, but also you could have some continued unwind of the yen carry trade, which puts upside pressure on the yen.
We've been hearing a lot about a rotation out of dollar assets into euro assets because the European asset managers and governments are angry. So that could support some kind of yen in euro against the dollar. But fundamentally, I can't imagine these currencies becoming that strong. And so I think their limits to how much dollar weakness you're going to get over the short term.
Over the medium term, I think we continue to see maybe the yen or as I mentioned the yen or the euro screngling a lot. So essentially maybe that helps to stabilize the dollar. And we actually think that their scope for the yuan to weaken. So if the yuan starts to weaken and that puts pressure on other emerging markets, who weaken a little bit, then that puts upside pressure on the dollar.
So over the medium term, maybe a little bit more dollar stability, even strength. And then over the long term, I think we're asking ourselves whether this is a big structural shift for the dollar. And I think the jury's still out. I would say it's hard for global investors to really move away from the dollar in the next 12 to 24 months in a big way just because of the dollar plumbing.
So it's hard to, you know, like why would you move into the Chinese yuan if the yuan might appreciate? Why would you move into the euro? But if we do get a US recession, German growth is only like 0.6% currently or forecast. So that's probably going to look pretty bad.
So do you really want to be in the euro? It's kind of like the dollar's still the worst, the best of the worst bunch in that sense. Over the long term, I think there's some pretty big questions. Do you get, on the one hand, a structural rotation out of US assets and that kind of reserves, equities, bonds, et cetera, which would then be probably negative for the dollar?
Or if Trump gets it right and he's able to narrow the fiscal deficit, he's able to narrow the trade deficit, get huge amounts of fixed investments into high-tech manufacturing, creates loads of jobs, renegotiate trade deals and get kind of a booming economy. That to me sounds like that's dollar positive. But it's a big if- Definitely you have to be seen. Although today we saw something that I was not necessarily expecting.
We now have an over 100% tariff rate on China. You know, China was definitely the number one focus for Trump in his first administration from a trade perspective and he doubled down on his China pressure during his campaign. But now here we are with 104%. I think it's the tariff rate on China.
Cedric, how are you thinking about the Chinese economy, the Chinese one? What is the game plan there? I think the game plan is really to beat the Chinese economy into submission almost. The US knows that the Chinese economy already faces significant internal pressures from the housing market.
I think Trump is trying to leverage now the external sector to apply a huge amount of pressure on President Xi and the Chinese economy. I don't think Trump is doing himself any favors by making it so publicly, by doing this so publicly, because it's very hard for President Xi to save face in any of these kind of under any of these threats. And so I think there could have been more eloquent ways or diplomatic ways of pursuing this strategy, but then Trump is not known for his diplomacy or him being eloquent. But I think the pressure valve here is the Yuan and I think there's going to be a lot of downside pressure on the Yuan given how much tariff rates have increased and the downside pressure on the wider economy.
So Beijing has basically four options. They can try and defend that level of around 7.3 against the dollar. Now that's difficult without burning through a lot of reserves and that may require some form of internal devaluation. That option is very painful politically and it's very bad for growth because ultimately you need to reflate your economy.
They could pursue a policy of one-off devaluation, right? So given the tariff rate, we see a minimum of like 10% devaluation as being meaningful. There's no point doing it 3% devaluation, for example 5% devaluation. So you need to have a kind of big devaluation.
The problem is that a devaluation of the size could potentially be destabilizing, right? So policy makers in Beijing are very much focused on financial market stability and as we've seen historically, sometimes you want to devalue by a certain amount but then speculators or your local households actually decide no, they don't want to hold your currency because they're worried about a larger devaluation and so it just provokes more of a selloff. And so I think that could be quite destabilizing. Also, it probably just angered Trump further, right?
If he's putting tariffs on your devaluing, he's thinking that you're trying to kind of get your way out of it. That would be good for growth though, right? It would help exports. Now, maybe you could strengthen the currency?
This would be very bad for exports. It would be good for household purchasing power and they're trying to say, hey, would they want to support the consumer more? Trump would probably be happy with that but it would be very painful for your external sector so I don't think that's a possibility. So we think that the path of least resistance might be to guide the Yuan lower and we think that the PBOC in government could guide the Yuan 10% lower over the next four quarters.
That would allow for a slow and steady depreciation which would support your exports and it would not hopefully for the Chinese authorities cause too much volatility or some speculative attack and it would be more discreet than it went off the evaluation. So it would take a while before Trump could say they're devaluing. So I think that there are no really good options here for the Chinese economy and for the Chinese Yuan but I think the path of least resistance which hits multiple goals is that Yuan being guided lower. Yeah, I mean, it's such a kind of prisoner's dilemma for so many different facets of the market and global economy and Cedric, the short term implication appears that recession is now on the table but there still is I think some optimism in some pockets of the markets or at least from people who I've spoken with that perhaps this could be positive over the long term if we see better trade negotiations and agreements put into place.
The thing I kind of struggle with is how much damage has been done, right? Given that he came out swinging so aggressively, is he overestimating the power of the US consumer and the power that he has as being the representative of the US consumer and is that just going to kind of eat away at any of the potential benefits? Does this say less than unintended consequences? How are you thinking about it?
Yeah, I think that's right in the sense that Trump is probably losing a lot of soft power or the US is losing a lot of its soft power right now but fundamentally this is a US dollar based system. Zach and I we talked about this last year in one of the podcasts. The US remains the biggest single consumer. The US remains the most liquid market and there is no real alternative.
You could potentially diversify your assets but that might overwhelm Europe. Also Europe is not the perfect currency union either. If you want to move into China, there are huge governance questions, political risk questions, capital control questions and so I think the US has a little bit of a leeway in terms of time to restructure without breaking the system but the risk is actually we see economies around the world and central banks around the world and portfolio managers move much faster in terms of their reserve diversification away from the dollar so we could see that happening and that will erode the US dollars exorbitant privilege. You could see weaker military alliances globally although if anything Trump is trying to boost his defense alliances with the likes of Philippines, I suspect Saudi Arabia as well, Japan, Korea so even though the US is a real thorn in their side right now ultimately they will have to lead, they will have to deal with a more powerful China both economically and militarily over the coming years and do you want the US to be your partner?
I think the answer is still yes. Now it requires some sacrifices, you have to pay for that privilege a little bit but I think the big question here as well is policy mistakes. If you're in a world where there's so much uncertainty, you're breaking things then the risk of a bigger more significant policy mistake emerges whereby some form of the plumbing gets broken and then you have an unintended consequence, you could have a potential military escalation by accident, you could get another politician like Trump in another country basically saying well to hell with it and I'm not playing by your rules. So there are lots of things go well generally but when you start weakening your fundamentals, even a small crisis can turn into a big one and I think the broad fundamentals of the global economy and the global system starts weakening and so it's more susceptible to these small crises escalating into something bigger.
Yeah, so many good points and I also want to highlight for the listeners that Cedric is based in Singapore so has a unique lens into looking at the US from living and working in Asia and talking to the client community in Asia as well. So I know a lot of times we tend to get very US centric and focused and so it's nice to have that kind of external perspective on everything that's going on. I think that we should probably wind it down there unless it's active, you have anything else that you wanted to add, anything that has kind of been shocking off for you in the past week or so. The one I'll point out real quick, Winnie, is the steepening of the two's 10s curve to 60 to 65 basis points.
That's not something we foresaw and frankly our call for the Fed to not move this year is correct. I think that's going to have to unwind in a pretty big way but that's been a big move even relative to what forwards have been pricing in for this year and frankly I'm not 100% sure what to make of it yet but I think that's something to watch that isn't being discussed in quite as much detail probably because there's a few other things to focus on right now. Just a couple of things to focus on. I suspect that this is going to be the name of the game for the foreseeable future, always a lot to cover and always great to talk to you Zach and thank you so much Cedric for joining us being our special guest.
We very much appreciate your insights and a little bit of the playbook into potential recession, why this one may look different, what's the Fed to do and of course the perspectives on China as well. Thank you everyone else for listening today. If you have any follow up questions for Zach or Cedric you can always find them by reaching out to your credit sites sales rep or using the asking analyst function on the credit sites website or shooting me an email and I will try and get your question in the right direction. Thank you guys for joining me.
Thanks for having me. Thanks Wendy. Thanks Cedric.